WealthManagement Magazine

Schwab Fined $1 Million for Lax Oversight of Non-Employee RIAs

Charles Schwab’s brokerage unit has been slapped with a $1 million fine for failing to protect customer assets from a check-kiting scam engineered by its affiliated—but independent—registered investment advisors.

Charles Schwab’s brokerage unit has been slapped with a $1 million fine for failing to protect customer assets from a check-kiting scam engineered by its affiliated—but independent—registered investment advisors.

New York Stock Exchange Regulation said on Tuesday that Charles Schwab & Co., a former NYSE member that relinquished its membership in early 2003, failed to oversee “a number of its non-employee investment advisors” who were forging checks and letters of authorization to withdraw money from customer accounts for personal use. As part of the settlement, Schwab must pay a $1 million fine for its negligence and retain an outside consultant to evaluate its internal policies and procedures. Schwab did not admit or deny any wrongdoing in the settlement.

The enforcement action reinforces the steady drumbeat of regulators that firms will be held responsible for failing to have the proper systems in place to detect misconduct, even when the wrongdoers are not employees of the company. “The case is a stern reminder that firms must have adequate procedures to supervise and control transfers of assets from customer accounts,” said Susan Merrill, chief of enforcement, NYSE Regulation, in a prepared statement. “It goes to the heart of the customers’ expectations that their money is safe.”

Regulators allege that from 1998 through the first quarter of 2003, Schwab did not have the necessary internal controls in place to monitor these disbursements and, thereby, failed to safeguard client assets. The Big Board’s regulatory arm found that Schwab did not maintain the proper transaction records for transferring funds from customer accounts to third parties. Among other things, Schwab did not conduct routine signature comparisons on wire instructions and failed to send confirmation emails to customers when funds were withdrawn from their accounts. While the investigation did not implicate any Schwab employees, the NYSE ruled that the firm was somewhat culpable because its compliance measures weren’t up to snuff.

“Even if member firms have independent relationships, the firm is still responsible,” says Brendan Intindola, a spokesman for the NYSE.

As for the RIA fraudsters, they fall under the jurisdiction of the SEC, which has brought enforcement actions against a number of individuals who allegedly plotted to steal from Schwab’s investors. One RIA in particular, Fred Schluep of San Mateo, Calif., was caught misappropriating roughly $5 million from 26 customers by forging their signatures on wire instructions, writing checks from the company’s account and forging checks from customer accounts to cover the funds he had misappropriated. Schluep used his clients’ money to maintain several commercial properties, operate an automotive brake company and pay personal expenses, according to the complaint. As a result, on Nov. 17, 2003, he was forced to pay a $120,000 civil penalty, $1.6 million in disgorgement and $236,993 in prejudgement interest.

Schwab has about 5,000 non-employee investment advisors who manage 1.3 million accounts, representing $350 billion in assets. The accounts managed by these advisors are custodied by Schwab, which charges trading commissions and other fees in return for clearing and support.

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